Wealthy Affiliate Members Promoting Pyramid Schemes
Over the last several weeks, I have seen several members promoting what are clearly pyramid schemes. As a result, I wrote and posted a review of one of the business opportunities. The bizop was obviously a hazard to your wealth.
Furthermore, I decided to write this post as a means to educate members who are unfamiliar with pyramid schemes as opposed to legitimate network marketing or multi-level marketing (MLM) companies.
What is a pyramid scheme
The current definition arose from a 1975 court case "FTC vs. Koscot Interplanetary," an MLM cosmetics company. The court created what was called the Koscot Pyramid Test. The Koscot Test has the following four parts:
(1) Payment of money to the company;
(2) The participant receives the right to sell a product (or service);
(3) The participant receives compensation for recruiting others into the program;
(4) The compensation is unrelated to the sale of products (or services) to the ultimate user.
The FTC and state regulators have applied the Koscot Test to every suspected pyramid scheme since then.
Industry has been pushing Congress to write legislation defining pyramid schemes (beneficial to industry). Left to the states, a legal business in one state could be deemed illegal in another.
However, consumer groups have been opposed to industry efforts to loosen the rules. The groups feel the legislation undermines the FTC’s ability to protect consumers from pyramid schemes.
U.S. legislation efforts to define pyramid schemes
There is no U.S. federal statute that defines pyramid schemes or makes them illegal.
In 2016, a group of U.S. lawmakers (28 co-sponsors) wrote and sponsored a House of Representatives bill H.R. 5230 – Anti-Pyramid Promotional Scheme Act of 2016 that would finally define what a pyramid scheme is at the federal level. The most important part of this legislation is that it defines internal consumption. This meant customers who are also distributors or members would be considered “consumers.”
Considering members as consumers would enable MLM companies to develop compensation plans based on the purchase and consumption of products by downline distributors rather than retail sales to third persons. This would negate part of the "Amway" rule regarding the requirement that 70% of distributor sales had to be made to retail customers. Otherwise, the distributors were not eligible for Amway performance bonuses.
H.R. 5230 died without passing when the 114th session of Congress ended.
However, H.R. 5230 was replaced by H.R. 3409 Anti-Pyramid Promotional Scheme Act of 2017 initiated during the 115th session of Congress. It too was cleared from the books when the 115th session ended January 2019.
However, the FTC litigates what they consider to be illegal pyramid schemes using other statutes, mostly related to fraud. Recently, the FTC shut down MOBE through the federal court system as a fraudulent business education program. The FTC alleged that MOBE representatives falsely claimed their business education program would enable people to start their own online businesses and earn substantial income.
Clearly, the FTC makes a distinction between legitimate MLM companies and those that cross over into being pyramid schemes based on the Koscot Test.
Critics may not like the MLM business model because of abusive practices. You can say, they are awful, but lawful.
What is the MLM business model?
Corporate business models define howcompanies operate. Among other things, the business model includes marketing, distribution, and revenue models. Part of their marketing strategy is to define how they will distribute its products.
A company may choose the MLM business model for several reasons. First of all, it reduces cost risk by transferring some selling, general and administrative (SGA) costs to the independent distributors. Independent distributors are responsible for recruiting, training, motivating, and supporting their sales forces with some oversight from the corporation. Lack of oversight got Herbalife into big trouble with the FTC.
Briefly, the revenue model includes the pricing model, which consists of price details and structure. Since SGA responsibilites and associated costs have been moved into the independent distributor network, The product unit costs should be lower since they do not include SGA costs. This enables the company to pay the multi-level/downline commissions.
This is where the FTC comes in. The FTC looks at MLM company compensation plans. MLM compensation plans are convoluted to say the least. However, over the years, the FTC has focuse on the compensation plans that tend to mask money games.or be abused.
The FTC has shown that they do not like matrix plans, particularly those that go beyond four or five levels. A non-MLM corporate sales organizational chart may show four or five levels (branch, division, state, regional, and national). Revenue models and cost structure normally won't support distributor payments beyond the fifth level.
What are the pyramid scheme and scam warning signs?
Business opportunities may be scams if one or more of the following warning signs are present.
- Promotional material that focuses on getting rich quick or no effort on your part (done-for-you).
- No selling on your part or no emphasis on selling to retail customers.
- Compensation plans based on a matrix beyond 5 levels including exaggerated claims of POTENTIAL income.
- Compensation based on recruiting new members.
- No retail products available for sale to the public or consumers.
- There must be a public demand for products. The classic example is the ACN videophone. The only demand was from the ACN distributors.
- Company has no operating history. New companies in pre-launch are high risk.
- Requirement to buy expensive products or sales materials including replicated websites or sales funnels.
- Lack of transparency as to the owners or no evidence of appropriate company registration with government units.
Please share your experience with pyramid schemes and scams.